UK Inflation: A Tale of Two Forecasts

This blog presents a further update of our forecasts using the methodology outlined in Binner at al (2024) and the previous update from May. We use the Multiple Recurrent Networks (MRN) framework to predict inflation for the 12-month period from May 2024 to April 2025.  For this purpose we are introducing an “intermediate” model, which consists of the following seven variables: the CPI price index level, CPI month-on-month inflation, the MPC Bank Rate, the PPI index month-on-month inflation, Sterling effective exchange rate, the UK 10 year guilt yield and real GDP. For comparison with our earlier forecasts, we will also include a simple model based on just the CPI level and CPI month-on-month growth. The intermediate model uses all of the data up to April 2024, as does the simple model.

The intermediate model predicts that inflation will fall again significantly in May to 1.6 per cent and then rise to a little above 2 per cent for the rest of 2024, remaining in the range 2.0-2.4 per cent. January will see an uptick, but will still remain below 3 per cent, and inflation will fall back to around 2 per cent by March and April 2025.  The predictions of the intermediate model are rather different to the simple model, which predicts an increase in inflation in the second half of 2024 to 3 per cent at the end of year with further increases in the first quarter of 2025 taking inflation to well over 3 per cent and indeed over 4 per cent by April 2025.

The message of the two forecasts is thus very different: the intermediate model suggest that inflation is already down in the Bank of England’s “target zone” (1-3 per cent) and will stay in this zone for the whole forecast period. Indeed, for most of the forecast period the inflation rate is close to the Bank of England target of 2 per cent. The intermediate model is picking up patterns from the additional variables that are missed by the simple model. From the point of view of monetary policy, this would suggest that interest rates may come down sooner rather than later since there is little concern about a rebound in inflation.

The message of the simple forecast is that inflation will leave the target zone by the end of 2024 and remain well above the Bank’s target for the rest of the forecast into 2025. This is very much in line with our previous Blog in May, but higher because of the out-turn of inflation in April 2024. Our previous Blog was also based on the simple model.

The use of the MRN methodology combined with our “drop-in drop-out” model of inflation enables us to update our forecasts quickly as new data becomes available.  We will be providing an updated forecast with the Complex model used in Binner et al. (2024) as soon as we have the data.  A we move through 2024 it will become clearer which MRN is more accurate in its predictions.